Oil markets and their transformation

International Petroleum Week 2015

February 2015

1

The information contained herein has been prepared by the Company. The opinions presented herein are based on general information gathered at the time

of writing and are subject to change without notice. The Company relies on information obtained from sources believed to be reliable but does not guarantee

its accuracy or completeness.

These materials contain statements about future events and expectations that are forward-looking statements. Any statement in these materials that is not a

statement of historical fact is a forward-looking statement that involves known and unknown risks, uncertainties and other factors which may cause our actual

results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-

looking statements. We assume no obligations to update the forward-looking statements contained herein to reflect actual results, changes in assumptions or

changes in factors affecting these statements.

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contained herein shall form the basis of any contract or commitment whatsoever. No reliance may be placed for any purposes whatsoever on the information

contained in this presentation or on its completeness, accuracy or fairness. The information in this presentation is subject to verification, completion and

change. The contents of this presentation have not been verified by the Company. Accordingly, no representation or warranty, express or implied, is made or

given by or on behalf of the Company or any of its shareholders, directors, officers or employees or any other person as to the accuracy, completeness or

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any other person accepts any liability whatsoever for any loss howsoever arising from any use of this presentation or its contents or otherwise arising in

connection therewith.

Important Notice

2

• Global oil price decrease in 2014

• Areas of concern in global oil price discovery

3

In 2014, the substantial fall in oil prices was not justified by the economic drivers

5%

 0%

 10%

 20%

 30%

 40%

 50%

 60%

 70%

 80%

 90%

 100%

 0

 10

 20

 30

 40

 50

 60

 70

 80

 90

 100

 110

 120

 130

2014 2010 2005 2000 1995 1990 1985

24%

1980 1975 1970

Oil price, $/bbl 1970 to 2014

• Over the past 50 years the

world oil market has passed

through a series of crises

caused by both economic

and political reasons

• The scale of the 2014 price

drop is reminiscent of the

drop in 1985 in real terms,

but with much smaller

economic drivers

• However the speed of 2014

crisis development exceeds

anything we’ve seen so far

• Average level of spare

capacities during the last 20

years was around 3%

• Current excess of supply

is seasonal and does not

exceed 1.5-2 MMBPD or

2%

* Adjusted for USA inflation and change in US dollar echange rate to currency basket

** Countries under sanctions, at war, etc. (Libya, Iran, Iraq, Nigeria, other)

Source: BP statistical review of world energy 2014

OPEC Spare capacity as % of

global demand, right scale

Adjusted USD oil price *, $/b. Global demand, MMBPD

Average excess capacity 3%

3

Unavailable

2 5

Saudi Arabia

Embargo of

Arab OPEC

members

Iran

revolution

Asian financial

crisis

World Financial

crisis

OPEC

resumes

historic

market share

Shale

boom in

the USA

• Growth of Asian

economies

• War, sanctions

and revolutions in

Middle East

Growth in oil

production from

new regions in

North Sea and

Alaska

4

The fundamental imbalance in 2014 is just a ripple on the water compared to the

oversupply tsunami of 1985

5%

of world demand

24%

of world demand

Shale oil Traditional fields

1985 2014

$30 - $50 /bbl $10 - $20 /bbl

$60 - $100 /bbl $30 - $40 /bbl

Spare

capacity

Marginal

Upstream

Operating costs

Marginal

Upstream Full

cycle costs

Demand

growth

Marginal oil

type

• In 2014/15, spare production

capacity is 5 times less than in

1985

• Excess production– seasonal and

less than 2 MMBPD

• Marginal production in 2015 is

shale oil with a high rate of base

production decline (30-50% pa

vs global average of 6%)

• The growth in operating costs

provides support for prices

• Growth in Full cycle costs points

to the inevitability of price

recovery

• Unlike 1980 and 2008 crises, in

2014 we have not seen a fall in

demand

Source: IHS CERA report: “Finding the critical numbers, 2007” , IEA, Wood Mackenzie, IEA

1979 - 85 1985 - 89

-7% +11%

2009 - 13

+7%

2014-20

+10%

6%

of world demand

Heavy oil, off shore

2008

$20 - $50 /bbl

$35 - $60 /bbl

2000 - 07

+13%

2007 - 09

-2%

31

60

1985 1980

104 -71%

47

115

2015

-57%

2010

67

105

2010 2005

-36% Oil Price

Real price, 2013 $/bbl

5

Plans to cut upstream CAPEX for 2015 by 20-30% have been announced, while

Rig count in the US is dropping sharply

Announced CAPEX cuts in 2015 compared with 2014 • Oil companies are cutting capital

investment plans – currently

announced -$65 billion, however

Wood Mackenzie expects $100

billion by the end of 2015:

– Total: 2 oil sands projects in

Canada

– Chevron: drilling in Canadian Artic

(Beaufort Sea), fracking project in

Poland

• The greatest investment decline is in

medium and small independent

companies, many of which are

involved in shale oil

• Over 20,000 headcount reductions

announced (including 16,000 in

Schlumberger and Baker Hughes)

• The US Oil Rig count has dropped

by 276 units (-18%) in January

alone

World drilling activity, rig count

-32%

-40%

-30%

-20%

-10%

0%0

-5

-10

-15

-20

Small

Independent

-18

Large

Independent

-13

-21%

NOC

-15

-20%

Majors

-18

10-30%

% change $ Bil % change CAPEX cut

Sources: Wood Mackenzie, IHS, Baker Hughes

1 223

0

50

100

1504.000

3.000

2.000

1.000

0

2015 2014 2013 2012 2011 2010

Oil price $/bbl World (Total) USA (Oil)

6

Actions taken to lower the oil prices undermine the investment basis of the oil

industry and damages the budgets of producing and consuming nations

Producing

nations

Consumer

nations

Large oil

companies

Small / medium

oil companies

Oilfield services

companies

• Considerable personnel reductions

Disruption of long-term investment may lead to oil deficit in the future

7 000

9 000

Baker Hughes

Schlumberger

• Many medium-sized companies are

exposed to the risk of financial

pressure due to weak balance sheets

and can become targets for

acquisition

-27% -29%-41%

-18%

Continental EOG Hess Chesapeak

Decrease of share value

on 06.02.2015 as

compared to 01.07.2014

• A considerable drop in revenues and

cancellation of investment projects

• Even in growing economies, the budgets of consuming countries can suffer because of lower centralized fiscal

revenues from major oil companies

• Increase in social expenses possible, to support laid-off employees of oil industry and adjacent industries

• Considerable budget deficits, as

growing expenses were based at an

assumed oil price of $100/bbl

SA Iraq UAE Algeria Kuwait Iran Nigeria Venezuela Angola Ecuador Libya

Threshold oil price to balance OPEC members’ budgets, $/bbl

Average = 115 $/bbl

Decreasing investments by

majors in 2015 as

compared to 2014, $ bn

Source: IHS, Bloomberg, MSN money

-5,0-5,0

-2,9-2,5Total

Chevron Shell

BP

Total expected

investment cuts: > $100 billion

7

A continued decrease of investment in exploration and production, against a

growing demand and declining base production, may lead to an oil deficit

Global demand for liquid hydrocarbons,

MMBPD

• The average rate of decline in base oil global

production is about -6% or 6 MMBPD

• The decrease of US weighted-average base

production amounts to -28% annually, due to high

rates of decline of shale wells (-30-50% per year)

• Today’s over capacity of 2 MMBPD may well be 

balanced in less than 1 year

Base production from current fields,

MMBPD

Sources: IHS, World Energy Outlook 2013

117,4112,4

101,5

92,6

76,7

 0

 10

 20

 30

 40

 50

 60

 70

 80

 90

 100

 110

 120

+16%

+10%

2040 2030 2020 2014 2000

• In the long term, population growth and a

large share of oil in energy consumption, will

ensure a growth in global oil demand

• All else being equal, demand growth alone

can balance the market within 1-2 years

8

The structure of current global production is misleading regarding the sources

of future production, the latter depending on resources available

Source: BP Statistical Review of World Energy 2014, Russian Ministry for natural resources and ecology; Rosneft est.

Canada

Middle East

Venezuela

Russia

Libya

USA

• Reserves added during recent years

• Oil is hard to recover (bitumen)

• Large reserves, considerable

potential resources

• New vast oil regions are already

under development (East Siberia,

Arctic, Sakhalin offshore)

637

10,8

1 909

28,3

200

10,0

205

3,9

393

2,9

86

1,7

Production, MMBPD

Potential resources, BBL

• Very small reserves

despite high rates of

production

• Unaudited reserves

• Mature fields

• Limited area for new exploration

9

Major oil companies’ CAPEXs increasing, against a stable or declining 

production level

Oil and gas production by Majors

Sources: est. by Institute of Economics and Finance of MIIT, quoted by Bloomberg

• Even during high oil prices, Majors didn’t ramp up oil and 

gas production

• Natural gas share in total hydrocarbon production of Majors

is increasing

• Oil and natural gas production by Majors amounts to 551

MTOE for the first 9 months of 2014, which is lower by 4.3%

than the previous year

CAPEX of Majors

* Quota and production given without Iraq’s share till 12.2011. Sources: est. by Institute of Economics and Finance of MIIT, quoted by Bloomberg • Capital expenditure of the majors grew continuously from

2005 to 2014

• Majors’ CAPEX doubled from 2005, Chevron’s rose by 4 

times

• However in 2014, Majors embarked on CAPEX reduction

and portfolio optimization programmes. As a result, Majors

CAPEX amounted to $109.5 bn, which is by 4.8% lower

than the previous year

• Given the low oil prices, this decline in exploration CAPEX is

likely to continue

99%

91%

107%

71%

87%

60%

70%

80%

90%

100%

110%

120%

I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV

2006 2007 2008 2009 2010 2011 2012 2013 2014

2005=100%

ExxonMobil Shell Chevron BP Total

241% 237%

432%

191%

263%

0%

50%

100%

150%

200%

250%

300%

350%

400%

450%

500%

I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV

2006 2007 2008 2009 2010 2011 2012 2013 2014

2005=100%

ExxonMobil Shell Chevron BP Total

10

• Global oil price decrease in 2014

• Areas of concern in global oil price discovery

11

Greater reliance on financial markets for oil price discovery leads to loss of link

between oil economics and the price

• In the past 20 years the open interest in

Brent and WTI futures has gone up by 9.5x

and 4.5x respectively while oil demand has

increased only by 32%

• This huge increase in paper trading results

in higher influence of financial drivers

• Financial markets are prone to bubbles:

dot.com crisis in 2000, subprime mortgage

crisis 2008.

• Oil supply is too important for everyday

life to risk to financial bubbles

• Even though efforts are undertaken,

financial markets are still prone to

manipulation such as (LIBOR rate fixing,

inflated AAA ratings for mortgage backed

securities)

• The oil industry requires stability and low

risks to support sustainable investment and

production

Volume of future open positions compared with global

oil consumption

Brent

WTI

Global oil

consumption

MMBPD.

Volumes of open futures

position, number of

contracts

Source: WTRG Economics, Rosneft

х9,5

х4,5

+32%

+32% 90

90

12

Despite a drop in oil prices and growth in company debt, share prices of US

shale oil producers are at January 2014 levels. Is it a new financial bubble?

Source: Barclays, Rosneft

European and US E&P companies share prices, % change • Since the beginning of 2014 shares of

European E&P companies fell by 42%

along with the drop in oil prices

• At the same time, shares of US shale oil

producers are at January 2014 levels.

Why?

– Have they increased productivity

twofold? Reduced their debt level

sharply?

– Has there been an adequate market

response and subsequent valuation?

– Is it an another bubble, in the US shale

oil? What will happen to the US

financial system if this bubble bursts?

- 42%

+ 1%

% change Europe USA Oil price

drop

01.2014 01.2015 08.2014

US energy companies bond yield, %

%

2011 2012 2013 2014 2011 2014 2013 2012

+67%

15,4% 10,3% 10,7% 9,2%

Share of energy companies in

US bonds index, %

• With the end of Quantitative Easing policy in

the USA the speculative capital switched to

US shale oil, fueled by tax breaks and

subsidies

13

Are US shale-focused companies overvalued? EOG valued 34% higher than

Lukoil with 3,9 times lower reserves and 6,6 times lower liquids production

• Upstream oil company

with assets in USA,

Canada, S. America and

UK

• No vertical integration

• Upstream oil company with

60% production in USA

and 40% in Europe and

Africa.

• Recently exited from

refining.

Vertically integrated oil

company with assets

exploration, production,

refining and retail in Russia,

Europe, Middle East, USA.

* As of 09/02/2015

Source: Wood Mackenzie, Bloomberg, company reports

Market Cap., $ bil.*

53

22

40

1 326

310

1 878

Refining capacity

Gas production

Liquids production

Liquids reserves 14 600

0

225

286

Gas production

Liquids production

Refining capacity

3 700Liquids reserves

0

84

231Liquids production

Refining capacity

Gas production

2 200Liquids reserves

Operational highlights, MMBPD, reserves in MMB

#1 in tight oil

production in

USA

2,1% global

crude

production

#3 in tight oil

production in

USA

14

Heavy and protectionist regulation harm development of the oil industry…

• US ban on oil exports along

with growing shale

production gives advantage

to local refineries which

hurts European refining

industry

• Growing oil demand in

Africa limits its export

capabilities

• Chinese oil

imports are

dominated by

State-owned

companies

• Sanctions against Russian oil

industry aimed at undermining

European crude supply and

support growing WTI / Brent

differential and may be

detrimental of European

refining industry

Source: IHS, OPEC

• State policies in

Mexico have led to

decreasing oil

production

2

0

2013 2010 2005 2000

4

Production MMBPD

MMBPD

• OECD high taxes on

refined products

distort consumption

patterns

40%

15%

45%

Oil price

Industry

margin

Tax

15

… and leads to regionalisation and unbalancing of the global market for crude

and oil products, which undermines global energy security

Governments of both consuming and producing

countries compete for extraction of rents from oil

The USA has a significant advantage over the

European average refining margins

WTI / Brent differential has created benefits for the US

refining industry

The structure of demand in Europe is significantly

different that production due to taxation regimes

- 10

 0

 10

 20

 30

 40

 50

 0

 50

 100

 150

2015 2010 2005 2000 Demand

75%

25%

Producti

on

65%

35%

 0

 5

 10

 15

 20

2000 2002 2004 2006 2008 2010 2012 2014

USA refining margin

European refining margin

Brent premium Brent WTI

Source: EIA, IHS, globalpetrolprices.com

$/bbl

$/bbl $/bbl Diesel Gasoline

Demand

30%

70%

Producti

on

38%

62%

EU USA

84

2213

Europe China USA

Taxes in consuming

countries

Taxes in producing

countries

38342920

CIS Africa Lat

Am

M.East

34 $/bbl 28 $/bbl

16

OPEC is no longer a united centralized organization due to disagreements

among its members

Since 1980s share of OPEC is

stable but:

• Interests of OPEC members

are not aligned – some don’t 

consider interests of countries

with cash constraints and high

social obligations

•Most OPEC countries lack the

substantial financial reserves

required to grow the production

(upstream investments) or to

reduce production (social

obligations)

•Only a group of Middle East

countries have substantial

financial reserves and spare

production capacity to decrease

/ increase production and

execute independent oil

policies

49%59% 61%

OPEC

other

2015

12%

17%

1980

41%

1973

51%

OPEC share in global oil production, %

Source: IHS, BP statistical review of world energy 2014, IEA, Wood Mackenzie, IMF WEO ; EIU, national statistics

39%

Venezuela: Expensive production

Iran: Sanctions and decreasing

production

Iraq: War and security issues

Libya: Revolution and civil war

led to 80% decrease in oil

production

-20

44147121

38

-24

3458

-156

2431

745

Ecuador Qatar Algeria Angola Libya Nigeria Kuwait UAE Venez

uela

Iran Iraq Saudi

Arabia

Net financial reserves / debt of OPEC countries, $ bln, 2014

Middle East group: Saudi Arabia,

UAE, Kuwait, Qatar

17

The oil pricing infrastructure is not reliable and requires improvements

• World oil market

fundamental data

which influences the

price are not

confirmed by

independent audits,

mainly oil reserves of

Middle East countries

and North America

shale oil reserves

• Forecasts of oil market

are often opaque, are

changeable and

exacerbate price

movements

Evolvement of the IEA

Forecast of World demand in

2014 MMBPD

Oct

2014

forecast

92,4

July

2014

forecast

92,7

Jan

2014

forecast

92,5

• Quotations by market

participants wildly

swing the market

“it is not in the interest of

OPEC producers to cut

their production, whatever

the price is. Whether it

goes down to $20, $40,

$50, $60, it is irrelevant” Saudi Arabia’s

oil minister

Ali al-Naimi

22.12.2014

• In May 2013 the EC

launched an

investigation about

Platts and other

companies and the

possible manipulation of

prices

“Pricing agencies can

be manipulated”,

IOSCO - 2012

01.03.2012

Source: Forbes, IEA, Reuters, IOSCO

Information Quotes Prices Forecasts 1 2 3 4

18

Forward curve and futures spreads

Brent forward curve

• After the decrease in spot market and “near" futures prices, 

price levels along the entire forward curve lowered.

• The forward curve partly reflects expectations about future

prices, as well as expectations about interest rates (through

arbitration with regard to spot prices).

• The long-term rate on futures market is now around $70

per barrel

• The futures market is in "contango" now (future prices are

higher than spot prices).

Brent futures spreads

40

45

50

55

60

65

70

75

80

фев

15

ма

р 1

5а

пр

15

ма

й 1

5и

юн

…и

юл

15

авг

15

сен

15

окт

15

но

я 1

5д

ек 1

5ян

в 1

6ф

ев 1

6м

ар

16

ап

р 1

6м

ай

16

ию

н …

ию

л 1

6а

вг 1

6се

н 1

6о

кт 1

6н

оя

16

дек

16

янв

17

фев

17

ма

р 1

7а

пр

17

ма

й 1

7и

юн

…и

юл

17

авг

17

сен

17

окт

17

но

я 1

7д

ек 1

7ян

в 1

8

$/баррель

02.02.2015 15.01.2015

30.12.2014 15.12.2014

-10

-5

0

5

10

15

20

янв

14

фев

14

ма

р 1

4

ап

р 1

4

ма

й 1

4

ию

н 1

4

ию

л 1

4

авг

14

сен

14

окт

14

но

я 1

4

дек

14

янв

15

фев

15

$/баррель6мес - 1мес 12мес- 1мес

18мес -1мес

• Higher oil prices at the end of January 2015 led to a

"flattening" of the futures curve and lowering of futures

spreads. In particular, the spread (18 months - 1 month)

dropped from $ 15 / barrel in mid-January to $ 12 in early

February.

Source: Bloomberg

19

Refining Trading

• Long term supply contracts for crude

and refined products

Retail

• Traders building assets in retail

• Producers gaining access to

retail in consuming countries

Business and real oil market participants may counter the growing risks with a

closer integration along the supply chain and by building long term relationships

Upstream

• Increased participation of

consumers in upstream

• Traders building assets in

upstream

• Producers invest in refining

projects in consuming regions

Midstream

Ruhr Oel

(ROG)

• Consumers provide financing for

building infrastructure

20

Regulators and oil pricing infrastructure managers should ensure transparency

for all market participants

Market

infrastructure

Market

participants

Exchanges • Develop regional oil trading venues, considering the characteristics of respective markets

and oil grades predominantly traded on them

• Monitor the impact of financial players on oil pricing and increase the role of real

producers and consumers.

• Increase the share of physical crude volumes in oil pricing up to 10-15% of total trade

flows

Development of a transparent and independent oil trading infrastructure:

• Reorganize exchange market infrastructure by enhancing the role of oil producers and

consumers in it, coupling it with a qualitative increase in transparency of exchanges in

order to reduce possible price manipulation (similar to the activities carried out regarding

bank interest rates and price agencies activity).

• Improve the efficiency and quality of market information (production, consumption,

inventory volumes, price information, conditions of oil contracting, etc.).

Suggested elements of oil pricing infrastructure development

Source: Rosneft